Investors can't get enough artificial intelligence (AI) these days.
AI has become not just a buzzword in the business world, but a truly transformative technology and the force behind new inventions like self-driving cars, autonomous robots, and chatbots like ChatGPT. According to some estimates, including one from Cathie Wood's ARK Invest, AI software could reach $14 trillion in revenue by 2030. While no one really knows how big the opportunity is here, it's likely to be impactful. Alphabet CEO Sundar Pichai even said that AI could be more profound than fire or electricity.
To capitalize on this opportunity, investors have been driving up AI stocks all year. One company, in particular, looks poised for huge gains if AI is as disruptive as some think it will be.
That's Upstart (UPST 7.99%), the consumer loan company that uses artificial intelligence to deliver what it says are more accurate credit scores than the conventional FICO scores from Fair Isaac. Upstart aims to expand access to the credit markets for those who have traditionally been locked out of them like racial minorities and young adults, including recent college graduates. Upstart says its AI technology provides a better determination of creditworthiness, allowing it to achieve 173% more approvals (nearly triple that of large U.S. banks) with the same rate of defaults. Its algorithms are trained on more than 44 million events and use 1,500 variables to make approval decisions.
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The case for Upstart to 10x
Credit scores are a fact of everyday life that often gets ignored, but the FICO score influences not just tens of millions of individual borrowing outcomes, but also the economy as a whole. Everyone benefits when it's easier for small businesses to get funding or when homebuyers have better access to mortgages. That suggests Upstart has a tremendous opportunity ahead if its AI technology is truly a better creditworthiness predictor than traditional credit scores.
The lending market seems tailor-made for AI. Upstart uses its AI technology to originate and service loans that it generally then passes on to its banking partners and institutional investors. It estimates that it has an addressable market of $4 trillion in loan originations, including personal, auto, home, and small business loans.
The company currently offers personal and auto loans, which together represent a nearly $1 trillion market opportunity. It plans to enter the home lending market this year with new home equity line of credit (HELOC) products, though it delayed its entry into small business loans due to macroeconomic headwinds such as higher interest rates and a tighter credit market.
Upstart's business thrived in 2021 when rates were low and consumer spending boomed, but since then the stock fell as revenue growth turned negative. The company went from generating a profit to turning a loss due to tighter lending standards, less interest in buying loans from its banking partners, and higher interest rates, which make it harder for consumers to borrow.
As a result, the stock is down more than 90% from its peak in 2021, which means that recouping those losses alone would make the stock a 10-bagger.
That won't happen overnight, but Upstart is already taking steps in the right direction. It expanded its number of bank and credit union partners to 99 from just 10 at its IPO. The company relies on these companies to buy its loans and provide lending as needed.
Its expansion into HELOCs should also help drive its growth, and it's already rebounding from the downturn as it forecast sequential revenue growth from the first quarter to the second quarter. Additionally, two rounds of layoffs in recent months should help drive profitability, and about a third of its float is sold short, setting it up for a short squeeze.
What's next for Upstart
There's no question that Upstart was hit hard by the rapid change in credit markets, but the Federal Reserve appears mostly done raising interest rates, and Upstart's situation should start to change as a result. The company's second-quarter guidance indicates that it's moving in the right direction. Revenue is on track to grow sequentially by a third to $135 million for Q2, and it expects break-even adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA), up from a loss of $31.1 million in the first quarter.
The excitement around AI should persuade more banks and credit unions to join up with Upstart, and a more friendly monetary policy would also give the business a boost.
If that happens, the company's upside potential is considerable. Investors already seem to be recognizing this, as the stock is up 166% since the beginning of May. With Upstart's market cap at just $3 billion, there's plenty of room for the rally to continue.
